Cyclical Stock

Cyclical stocks are shares of companies whose earnings and stock prices rise and fall in tandem with the broader economic cycle. When the economy is growing and consumers/businesses are spending freely, cyclical companies boom. When recession hits, their revenues and profits drop sharply because consumers cut discretionary spending and businesses delay capital investments.

Why Some Companies Are Cyclical: The economy runs in cycles of expansion and contraction. Cyclical companies sell goods or services that people and businesses postpone or stop buying when times are tough — discretionary items, big-ticket purchases, industrial equipment, luxury goods.

Classic Cyclical Industries:

• Automotive: Car sales collapse in recessions (people delay buying)
• Housing/construction: New home starts and renovation contracts fall
• Steel, copper, materials: Industrial demand drops sharply
• Airlines, travel, hospitality: Discretionary travel is first to be cut
• Luxury goods: Expensive items defer well during downturns
• Semiconductors: Capital spending by tech companies slows
• Financial services (banks, asset managers): Loan demand drops, assets under management decline

Cyclical vs. Defensive Stocks:

• Cyclical: Ford, General Motors, Caterpillar, U.S. Steel, Las Vegas Sands, Marriott
• Defensive: Procter & Gamble, Coca-Cola, Johnson & Johnson, utilities, grocery chains (people still need food, medicine, and electricity in a recession)

Investing in Cyclicals: The ideal time to buy cyclicals is at the bottom of a recession or early in a recovery, when valuations are depressed and the next expansion is beginning. The worst time is late in an economic expansion when earnings are at peak levels (and P/E ratios may look cheap but are based on unsustainably high earnings).

P/E Ratios and Cyclicals: One trap: cyclical stocks can appear cheaply valued (low P/E) at the top of a cycle when earnings are high. When the cycle turns down, earnings collapse, making the "cheap" stock expensive in hindsight. Investors use Shiller P/E (cyclically adjusted) or Price/Book to better evaluate cyclicals.

Indicators to Watch: GDP growth, PMI (Purchasing Managers' Index), unemployment rates, housing starts, and consumer confidence surveys all signal where we are in the economic cycle.